Brexit, the one bright spot in the global economic gloom

How the tide turns, one of the only positive bits of news for financial markets today is Brexit, elsewhere, a wave of weaker than expected economic data has weighed on risk appetite and sent US and some European stocks falling on Wednesday, while the pound soars to its highest level since mid-May. 

Why bad news could be good news for US stocks 

Looking at the economic data first, the US retail sales report for September showed that sales fell by 0.3% for the month, missing expectations for a 0.3% increase. The market has ignored the upwardly revised 0.6% sales growth for August, instead concentrating on the decline in the sale of motor vehicles, building materials and hobbies. Even online sales fell in September, which is a clear sign that the mighty US consumer could be pulling back. The real test of US consumer strength will come in the next few months, with Black Friday and Christmas all in the pipeline. A disappointing Black Friday could trigger a bigger wave of panic across financial markets and risk assets in particular. From a trading perspective, this data has pushed US stocks lower, and the S&P 500 is down 0.3% so far today. However, the decline may not last as the index is currently trading above 2,980, which is close to the psychologically important 3,000 level. It is worth watching this index closely – will investors be able to look through weak economic data and push the S&P 500 above 3,000; we believe that this is possible, particularly if the market views weak economic data as a sign that the Federal Reserve will cut interest rates at their meeting at the end of this month. Thus, bad economic news could be good news for US stock markets in the next couple of weeks. 

Looking for a U-turn from the Fed 

The market is pricing in a 86% chance of a rate cut by the Federal Reserve at this month’s meeting, which is a large swing in expectations, considering one month ago the chance of a rate cut was a mere 32%, yesterday expectations for a cut were at nearly 74%, which highlights how sensitive the market is to US economic data at this juncture. While a rate cut from the Fed in October is starting to feel like a certainty, the focus is likely to shift to December’s meeting. The Fed meet for the last time in 2019 on December 11th. 

Expectations that US interest rates could be cut twice by the end of the year to 1.25%, currently stand at 18%, this is pretty much flat for the month and is actually lower than the near 20% chance the market expected yesterday. What does this tell us? 1, that investors do not think that the Fed will cut in December if they cut in October, and 2, it would take a significant deterioration in the economic data to change the market’s expectations. Thus, in our view, this makes a move back above 3,000 in the S&P 500 possible in the medium term. 

Political momentum (finally) boosts the pound 

The pound continues its ascent higher; it is currently trading above $1.28, and its upward momentum looks unstoppable. As political momentum to firm up a deal has picked up, so too has the market’s resolve that the UK will leave the EU with a trade deal either on the 31stOctober, or shortly afterwards. The Brexit secretary told a Commons Select Committee that the government would abide by the Benn act and ask for a short extension to the Brexit process, if a deal is not agreed and ratified by the UK’s Parliament by Saturday night. This has triggered a wave of positive sentiment towards the pound because: 1, the government is unlikely to go rogue and dismiss the terms of the Benn Act to ensure that we leave the EU with a deal; and 2, the prospect of a no-deal Brexit looks like it has been put to bed once and for all. 

Of course, there is still a chance that any deal agreed by the EU and the UK will still fail, apparently the DUP are demanding talks with the PM as we speak. However, we imagine that the PM will have a trick up his sleeve to win over the DUP, even if they end up costing the UK as much as EU membership did in the long term. While we won’t delve any further into the shenanigans at Westminster, there is undoubtedly a positive mood as we move into tomorrow’s EU leaders’ summit, and this could be enough to soften the long-term pound sellers. However, we believe that GBP/USD will have to climb above the $1.30 mark before we get true pound sellers to unwind their positions. If the DUP make positive noises that a deal can be reached with the EU to take the UK safely out of the UK, then we expect the pound to soar and real money to come looking for pound longs. 

Why we are starting to warm to the pound 

The long unravelling of short pound positions could be upon us, and this could be good news for GBP in the long-term. Even though the UK’s headline inflation rate remains below the BOE’s target rate of 2% at 1.7%, for September, and there appears to be a synchronised global economic slowdown, we continue to think that the future could be bright for the pound after a Brexit that is accompanied by a deal with the EU. Firstly, we believe there could be a big boost to business investment, which has slowed down or been halted completely in recent years due to Brexit uncertainty, secondly, the BOE is less likely to cut interest rates if we leave the EU with a deal, which could also boost the pound.  

Why we are cautiously optimistic about Brexit 

Thus, this Remainer is cautiously optimistic about the outlook for the pound this week,  and I can say that in the three years since we voted to leave the EU, this is the first time that I have had a feeling that the pound could be in for a prolonged bout of strength. This week’s EU summit and this weekend’s special sitting of Parliament to vote on the Brexit deal will determine if I am correct.